James Wheeler sits down to crystal ball gaze with the ever resourceful Jon Moulton of Better Capital

According to Jon, global funds north of $10bn are still being raised, to many a private equity investor's bafflement. But Jon also foresees some events that could simultaneously build up to a "mechanism of breakdown" for the private equity market. But do not fret completely over your New Year's champers, there's always management fees....

Do you think that the private equity model of several years ago is truly dead, as is the thinking on the street, or like bankers' bonuses, life will revert to the old status quo? And if so, why?
The old private equity model is by no means dead. On the contrary, there are global funds north of $10bn being raised. And I cannot give you the answer that justifies this level of capital to be deployed.

However, there is already 3⁄4 of a trillion dollars in dry gunpowder sitting in the industry. It's going to take the next decade to invest it. It just doesn't make sense to see so much being raised, especially since there are relatively low levels of debt available, which then brings down leverage possibilities.

It's bizarre that private equity deal valuations are higher than ever, with 2/3 equity and 1/3 debt producing multiples of up to 17 times EBITDA. There was an excellent recent study by the Ohio State University that reported that the private equity investment model shows no discrimination in both stable and unstable economic markets. The report also said that highly leveraged deals were the worst performing investments. The industry can do better!

With uncertainty looming over exit prospects and leveraged financing, what type of ROIs are firms expecting to achieve when an exit opportunity does arise?
In a recent electronic polling session I conducted at a conference, respondents on average said that three years ago they were betting on ROIs of 20%, now they are estimating about 11 % ROI. But when asked about actual ROIs their estimations were in single digits.

What I do see changing in the private equity model is the industry's level of liquidity over time. The industry will get smaller. Why? Because half of the total money raised in the private equity market went out between 2005 and 2007. That has created a wall of unrealized investments. If interest rates go up, there are going to be some serious casualties in private equity funds.

With many firms starting to feel pressure to invest money they would prefer not to return, and all seemingly pursuing the same sectors (healthcare, business services, etc.) what dangers and cliff edges do you foresee?
The nursing home and healthcare service sectors look very frothy at the moment, with multiples being on the high side all things considered. Being agnostic about interest levels, there may be some more retail and public sector outsourcing business opportunities, but when it comes to the turnaround space, where we specialise, a lot of this deal flow will be in the form of restructurings.

What about opportunities or anticipated events coming out of the Eurozone?
Many people would be surprised to know that the lowest level of corporate bankruptcy in Europe is in Ireland, then Greece, followed by Spain and Portugal. The reason being these markets aren't willing to crystallize losses. A serious reality check is required, especially with all the sleeping zombies on the banks' books.

Within stressed investing, everyone is pointing their fingers at the banking community's reluctance to pull plugs: should they be waiting for an inevitable tidal wave or should they be looking elsewhere?
If I had my way at the moment, I'd be headed to the Tiger economies, but Mrs. M isn't having it! That's where a lot of opportunities are cropping up, but I'm staying put and focusing on the UK.

What people need to realise is that in today's market, the turnaround sector is thin. It represents 2% of the private equity market. You're looking at about €400m in deal flow per annum. Mainly because it is considered risky and not just anyone can build a network to execute the deals. To put this into perspective, Better Capital represents 25% of the European turnaround investment market.

Deal flow is there, it's just that the banks are handling the majority of the "turnarounds" internally. They're drip feeding or rolling over loans to keep companies on their books rather than lending fresh capital to new deals. You hear a lot about banks stretching covenants, adjusting term agreements and offering debt to equity swaps.

But all it will take is for interest rates to rise and this place will be packed.

It's been asked many times, but are there any signs that venture might be making a comeback?
Much to my regret, not likely. Venture funds returns can barely cover the fees. There is a shortage of good target companies in the UK, not money. There's an equity hole. We need companies to come forward and have management with backable backgrounds behind them.

The venture market needs a more anti-free market agenda backed with government support; not the penny packet quarter million here and million there. Many university spin- outs just fizzle away after the first year of investment since the company cannot survive on that investment alone. The professors aren't overly incentivized to make it work with many just returning to their jobs down the corridor.

What the UK venture market needs is critical mass in talent and complex technology. The UK has to become more attractive to lure the talent, like we see in California and Israel. We need more liberal employment regulation that gets rid of counterproductive quotas and that incorporates tax incentives to bring the foreign talent to the UK.

What trends do you see continuing or developing as a result of economic uncertainty?
There is an unprecedented amount of private equity investments, about two thirds, which are being realised through secondary buy-outs. This is creating a new world within the private equity market.

We're seeing some firms relying more than ever on management fees with the objective of raising new funds being a means to making more income.

We're also seeing in research reports that there is no consistency when it comes to fund performance. The last fund does not determine the performance of the next fund.

In 2007, you publicly predicted the economic downturn. What are your forecasts for the year ahead?
Interest rates and the health of sovereign debt will determine the fate of private equity. But it will be the interest rate that will determine everything: it's the mechanism of breakdown. Rising interest rates paired up with other events could lead to the UK running into pain immersion rather than pain aversion.

One of these events could be the collapse of sovereign debt markets, which would be contagious, making interest rates rise irrespective of political desires.

In the past, this type of event precipitates interest rate rises that go up in fast succession, from half a point, to three quarters of a point to suddenly two points. Currency instability in the Eurozone could also be adverse for the economy and for growth.

But if all goes well in 2011 we will at best see a weak year for the UK economy. I think we will see some civil unrest as unemployment rises closer to 9% paired with the VAT hike biting in alongside low levels of both capital expenditure and construction.

Private equity funds need to dig in [to make the best of their portfolios]. Money under management will start to go down. And people do not sell things when pricing is uncertain, so I suspect we will still see even more pass the parcel in the secondary buy-out space as other buyers are rare.